Blenderlaw

After years of seeing US regulators travelling around the world telling everyone else that they didn’t get financial regulation it’s striking to see the New York Times report that foreigners are asking for a say in how the US markets are regulated. Striking, but not surprising. After all, the collapse of the subprime lending market in the US, and its impact on securities based on those loans occurs a few years after the events at Enron, Worldcom, Tyco etc., and at a time when commentators in the US have become increasingly vocal about the costs associated with Sarbanes-Oxley compliance.

And it isn’t as if regulators around the world hadn’t recognised the risks in the development of the subprime lending market. In January 2006 the Committee on the Global Financial System published a paper on Housing Finance in the Global Financial Market which raised a range of issues, including questions about the potential impact on financial stability of the relationship between domestic markets for housing finance and international securities markets. For example:

The rapid growth of sub-prime lending in new markets, combined with the introduction of new and complex loan types, could raise some issues for financial markets. One question is whether lenders and investors are able to assess accurately the risks of this lending, given a lack of previous experience. Another question is whether the risk of contagion from larger domestic housing finance markets via bond markets has increased. This aspect has until recently mainly been an issue for the US market, but could become a broader concern as this form of lending grows in other markets.
As investors create diversified global housing finance-based portfolios, it is likely to become less clear who ultimately bears which risks and whether new risk concentrations are emerging. For central banks, regulators and policymakers more broadly, assessing linkages as well as potential build-ups of risk will become more challenging. It is possible, though unlikely, that these risks, if not checked by prudent oversight, could offset the diversification benefits from having access to a broader set of mortgage bond markets.